Hong Kong Regulator Issues Circular on Tokenized Investment Products

Hong Kong’s Securities and Futures Commission (SFC) has issued a comprehensive circular outlining the regulatory framework for tokenized investment products. The circular provides clarity on the requirements and safeguards that must be met for the tokenization of SFC-authorized investment products. While it encourages primary market transactions, it adopts a cautious approach to secondary market transactions and restricts the use of permissionless blockchain networks.

Tokenization of investment products involves creating blockchain-based tokens that represent ownership in these products, which can be offered to investors digitally, distributed through SFC-licensed intermediaries, or traded on blockchain networks. This emerging trend promises increased efficiency, reduced operational costs, and expanded access to investors.

The SFC has been evaluating various proposals related to the tokenization of SFC-authorized investment products. These proposals cover primary transactions, such as subscriptions and redemptions, as well as secondary trading on SFC-licensed virtual asset trading platforms. The regulatory approach adopted by the SFC is marked by a commitment to transparency and investor protection.

Primary vs. Secondary Market Transactions

The circular makes a clear distinction between primary and secondary market transactions for tokenized investment products. Primary market transactions are seen as less risky and are thus encouraged, provided that the underlying product meets all applicable authorizations and additional safeguards to address new tokenization-related risks.

Secondary market transactions, on the other hand, are viewed with caution. Ensuring a level of investor protection comparable to that of non-tokenized products requires careful consideration. Key considerations include maintaining accurate token ownership records, readiness of trading infrastructure and market participants, and fair pricing of tokenized products.

The SFC will continue to engage with market participants to develop appropriate measures for addressing risks related to secondary trading of tokenized investment products.

Requirements for Primary Dealing

For tokenized SFC-authorized investment products, product providers are expected to adhere to several requirements. These requirements cover tokenization arrangements, cybersecurity measures, and disclosure obligations. Key points include:

  • Tokenization Arrangement: Product providers must be responsible for the management and operational soundness of tokenization arrangements and ownership records. They should maintain proper records of token holders’ ownership interests and demonstrate the integrity of smart contracts. Using public-permissionless blockchain networks is discouraged unless additional controls are implemented.
  • Disclosure: Offering documents for tokenized products must provide clear information on the tokenization arrangement, ownership representation of the tokens, and associated risks, including cybersecurity and evolving regulatory landscapes.
  • Intermediaries: Distributors of tokenized products must be SFC-licensed intermediaries and comply with existing rules and guidelines, including conducting client onboarding and suitability assessments.
  • Staff Competence: Product providers must have staff with the relevant expertise to manage tokenization arrangements and address technology-related risks.

Prior Consultation or Approval

For new investment products with tokenization features seeking SFC authorization, prior consultation with the SFC is required. The same applies to tokenization of existing SFC-authorized investment products. The rapidly evolving nature of the tokenization landscape may lead to additional requirements in the future.

In conclusion, the SFC’s circular provides a clear regulatory framework for tokenized investment products, balancing the need for innovation with investor protection. As the blockchain and tokenization landscape continues to evolve, the SFC remains vigilant in its commitment to safeguarding the interests of investors in Hong Kong. Market participants must adhere to these requirements to ensure the growth of tokenized products in the region while maintaining the highest standards of integrity and investor protection.

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